More on the falling rial

I have not been able to write much on this blog because I have been trying to catch up on my research. But the rial troubles in the last two weeks have been impossible to ignore. I am not a macro economist, but some of what the media was reporting about the freefall of the rial even I knew was over-sensationalized — hyperinflation, economic collapse… and one Iranian BBC reporter said he had run out of words to describe it! Yesterday I tried to explain on the lobelog three things.

First, there is a difference between the rate in the parallel market and the average rate of exchange for the country because of the multiple exchange rate system. Second, the sharp rise in the value of foreign currencies in the parallel market was not a classic run on Iran’s currency, but rather caused by reduced infusion of currency into the parallel or free market. Third, Iran’s economy is not on the verge of collapse, as some people were saying (or hoping). In short, I tried to define the currency crisis in Iran in its own terms rather than the textbook cases from East Asia or Zimbabwe that immediately come to mind. The one factor that explains most of the difference is oil, which means that the supply of foreign exchange is not in diverse hands but concentrated in the hands of the government. While many people maybe buying and selling dollars at 35,000 rials, the government can decide to sell its dollars at a lower rate.

Admittedly, the situation in Tehran is both confusing and shrouded in secrecy– for understandable reasons –and I do not claim to fully understand what is going on between oil exports, frozen and unfrozen Central Bank of Iran (CBI) accounts abroad, and rupees and yuans. But some reporters I talked to in the last few days did not know that Iran had a multiple exchange rate system, or that currency crises in oil exporting countries are different from those in which private sector earns the bulk of the foreign exchange. So, it seemed there was reason to say something.

With its diminished oil revenues the government can still shield large sections of the economy from the adverse impact of large devaluations in the the parallel market. The import classification system put into place last December was precisely for that. I do not know how much of the CBI forex goes to basic goods, how much to the Exchange Center, and how much, if any, to the parallel market. My guess is that, for obvious reasons, this market is not near the top of the list CBI priorities for cash infusion. I am not sure if any central bank faced with the same difficulties would use its foreign currency to calm a currency market gripped by fears stemming from tightening sanctions, even war. Any politician who decides otherwise would have to answer to voters (or people in the streets) when the country runs out of foreign exchange for essential imports.

In my view, given the sanctions and the emergency conditions that the country faces, the decline in the value of the rial in the parallel market is not at all surprising It should be no more a source of shock or surprise to see high ticket prices outside sports or entertainment events, especially when the quality of the event is uncertain beforehand. There are people who believe that scalpers should not be allowed to buy and sell concert tickets, and there are those who believe that such trades at the curb even at very high prices have their place. I happen to belong to the latter group. However, I fear that with the hoopla over the “rial’s collapse,” the government may run out of patience with the free market and send it underground. That would be unfortunate.

Some readers of my Lobelog post thought that it painted an overly optimistic picture of the situation. I had said that the currency crisis did not amount to economic collapse. It is also true that, as a matter of habit, I did not discuss conspiracy theories (which I rarely believe), such as those that would blame the government for creating this mess on purpose in order to make more rials, or those that blame a few ringleaders for corrupting the system. (But, as they say, just because you are paranoid it does not mean that they are not out to get you!)

Sanctions are not a game. They are designed to inflict pain on the people of the country they are imposed on, and as we have seen they are doing just that in Iran, and not all social strata feel the pain at the same rate. Iran’s government is in a position to decide who gets hurt more and who get off with less pain. For example, it has decided that keeping chicken production going is more important than paying the tuition of thousands of students abroad. That is a choice that many would disagree with, but to say that it makes sense from the point of view of Iran’s government is not to minimize the gravity of the situation or the level of pain on those who lose more than others. If the economy has not collapsed, economic growth has and with it the hopes of young people for finding a job and setting up new families.

To confirm Dr. Salehi’s point about the combined effect of the two tier exchange parity, here is an excerpt from a long interview in an Iranian trade publication from a year ago. Note the similarities between the present situation and the war time economy of the eighties.
– سود از کجا می آمد؟ چگونه چنین مسئله ای که همگی در آن سود ببرند وجود داشت؟ و در نهایت کالا هم به قیمت ارزانی در اروپا به فروش می رفت؟

It is mostly nonsense. The hyperinflation thesis that this guy promotes (and I have tried to dispel) will soon prove wrong. It is a month since the so-called collapse of the rial and prices for basic necessities have not increased by much — bread, energy, chicken. I am not sure where this guy gets his facts from. Serious economists do not talk like this about a country they know nothing about — Soviet-style planning?! (BTW, there is no department of applied economics at Johns Hopkins.)

I doubt very much that Iran will be unable to print its own money or will not be able to find somewhere to print it. this is all part of the restructuring that Iran should have been doing a year ago in anticipation of the sanctions, but now has to do it in a hurry.

I think the point of this article that shortage of notes will either cause further disruption or help rein in hyperinflation is fanciful. The former is part of the anti nuclear-Iran lobby and seems interested in telling its sponsors that it is a big player in the anti Iran policy circles. The other — hyperinflation — is a misguided story that NYT and other media have been pushing and I believe is misguided.

[…] trods de økonomiske konsekvenser for befolkningen ikke står over for et kollaps. Han skriver på sin blog: Sanctions are not a game. They are designed to inflict pain on the people of the country they are […]

For more than ten years Iranian economy suffered from an inflation rate of around 20 percent annually, while self-serving top bureaucrats kept pegging Iranian Rial at a fixed parity of close to 10,000 Rials per dollar. Sustaining this over-valued Rial, has cost the treasury hundreds of billions of dollars of oil revenues and damaged the farming, manufacturing and non oil exports sectors of the economy. Meanwhile, they were enriching themselves, the civil servants and the upper middle class, while impoverishing farmers and manufacturers through competing cheap imports. Squandering money on luxury imports (thousands of Porsche and Bugatti ….cars) and vacations in expensive hotels on Mediterranean shores (not the Caspian) became a status symbol.
Now, thanks to sanctions, those top bureaucrats have come to their senses and allowed the Rial to slip to its real market value. Thus, reducing the budget deficit by timidly selling petrodollars and gold on this secondary market, while blaming currency speculators for the further increase. Of course this inconveniences the millions of civil servants and their families, mostly populating Tehran, and benefiting from years of cheap imports. They will not like the devaluation, and are likely to be complaining openly. The manufacturers, the workers, the farmers and specially the exporting industries are benefiting from the new situation. The country should see increase in both GDP and employment after some initial adjustment. Already cement exports are doubling compared to last year, and there is a noticeable trend towards using more local products in the construction, finishing and furnishing of new buildings. Iranian economy would gain substantially from this timely devaluation.
Sanctions have acted as cathartic agent for a nation that once prided itself on creating extensive irrigation networks in the desert through its own labor over several generations. Indeed more than 50,000 qanats (kariz), and the towns and farms created around them represented the largest long-term per capita investment the private sector had achieved in any country until modrn times.
The Iranian people, over several thousands of years, have survived plots and schemes hatched by more intelligent foes than the ‘coalition of unwilling’.

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Meanwhile an Iranian economist Babak Azad claimed that the economy was on the verge of collapse, citing cement industry as an example.

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October 7, 2012 @ 2:48 pm

Unlike Mr. Azad I am not an economist but a businessman living in a town in central Iran. I know, first hand, the following assertions to be true:

– Most farmers in our area are benefitting from Rial devaluation. They are selling farm products at close to world prices at free market parity, while buying inputs only 20-30 per cent higher than a year ego. They are not so much dependent on imported goods or food items.
– over the past four years the price of cement has gone up only by 25 per cent, thanks to an over capacity of 15 million tons. Non-the-less, on 3rd Ocober the cement plant close to where I live has increased its profit estimate for the current Iranian year by 80 per cent, citing higher revenues from exports at new exchange rate as a major reason; I know because I am a shareholder. Iran’s cement exports are almost doubling this year compared to last year. No surprise, because the major inputs in cement production are marl (clay and limestone), gas and electricity – all still dirt-cheap in Iran.
– Although oil exports are down, but one should not forget that if we were importing the energy we use, like Turkey, the Iranian nation would have had to pay an additional bill to the tune of USD 120,000,000,000.-. Whether we are squandering it or optimizing its use is a different matter! What more do we want from the oil and gas industry? With that massive subsidy, which at present exchange rate would amount to Rls 3,600,000,000,000,000, are we still a poor nation unable to take care of ourselves?

Thanks for the suggestion. I read the article. It did not relate to what I daily experience, living in a provincial town in central Iran. Yes some prices have risen more than usual. But even more so have farmers incomes and manufactures incomes, specially in sectors like textiles and locally manufactured farm and food processing machineries. These and nearly all private sector manufacturing was strangled.previously by cheap imports. Already, the textile industry has grown by more than thirty per cent over previous year.

The article lacked any analysis of the Iranian situation. It talks about misery and angry protests. Of course in any major economic adjustment there would be a redistribution of incomes. This time it is the huge beurocracy that is feeling the pinch and they are very vociferous. That is why you saw only a limited protest in their home town, but a lot of media coverage.

Meanwhile, it is interesting to know that an article apearing in an industrial periodical about a year ago predicts that under restricted oil revenues we should expect a dollar parity of around Rls 40,000. At that time one dollar stood at Rls 13,000. Please see pages 36-37 of the periodical :http://www.pistachioassociation.com/fa/documents/0.global/khabar_nameh/____1390_copy_copy.pdf
The title of the article is “The Real Dollar Value?!”
So, where do you see the hyper inflation? It is only an adjustment!

Does anyone know roughly the volume of dollar holdings by the private Iranian citizens. I know for sure people had started buying dollars a long time ago as a hedge against the devaluation of Rial, and to keep them as savings. I wonder whether some of those privately held dollars are showing up on the “parallel market”.

Donyaye eghtesad reported today that, according to a majles deputy, Iranian households are holding $14 billion. This has nothing to do with underground economy statistics because this is no an official statistic, it is just an estimate. I am not sure why CBI wants the banks to hold these dollars instead. Does it really think people will part with their dollars at this time. It would have to pay a very large premium to persuade them that their savings are safe at the bank.

Dear all, I’m a social anthropologist by training, so I have found this thread quite informative. I have a quick question:

When the govt. announced the setting up of the Forex Centre it received criticism for pricing the rial according to the free market (I believe it was <2%). These criticisms argued that in doing so the Centre was merely reacting to the rial's free market value and thereby failing to actually stem it's continued fall. Sure enough, within a week or so of the Centre's launch, the rial depreciated very suddenly. Does this argument hold water? Are there other variables at play that it doesn't not consider?

I would really like to know more about how the forex centers work. Are they auction markets? I assume that participants (bidders?) are vetted first for the type of goods they are importing. I also believe the main seller is the CBI. Any insights?

“keeping chicken production going is more important than paying the tuition of thousands of students abroad”, OK, but what do you think about importing luxury cars using government subsidized dollars according to Fars News Agency? Is that also more important than helping students continue their studies. Besides, this students mostly do not pay their costs out of their packets, it increase the financial burden on Iranian middle class households. While if these students go back to Iran (as it’s happening now) it’s billions of dollars waste out of their uncompleted educations. Moreover, I think your view is too optimistic about Iran government, e.g. you think government do not care about Rials it gains over this process? Even though the new foreign exchange council has been established by Ahmadinejad himself, and is selling dollars almost exactly on market price? For the first time after Iran revolution (I beleive), CBI is doing nothing to control the dollar price and at the same time government reaction is to gain from high dollar exchange rate and you are telling us that who think it is on purpose, are into conspiracy theory? I don’t get that!

Thank you both very much. Your consolations, coming from two (almost) independent sources, are so comforting. Nevertheless next summer is when one will not need much statistics or economics to know, for sure, what the yearly inflation rate has been, 50%, 100% or more.

You know as well as I do that, at any point of time, a 10% monthly inflation rate is equivalent to more than 300% yearly inflation rate (1.1^12 = 3.14). And if you have been monitoring prices during the last few months, you know that they have risen by more than 10% a month.

There is another argument leading to the same rate. Historically, inflation has always been highly correlated with increases in the exchange rate of Dollar, with a lag of a few months (with a slope greater than one). You can see this by studying the corresponding time series. We all know that the value of Dollar (in Rials) has more than tripled since last year.

Your point is well taken, if we continue to have monthly inflation rates of 10%, then we will have a hyperinflation of 300%. But this trend cannot continue. To have a 300% inflation at the end of a year, you must assume that the money supply will increase by that amount, or the economy almost will completely collapse (by more than 50% for example), or a combination of the two. And I highly doubt that. My wild guess: an inflation of around 55% give or take 15% would be in line with what happened in 1373 (1994?) data.

Dear professor Salehi
A year ago, in your post, you echoed another prominent economist in praising the introduction of cash subsidies and raising energy prices, in the face of tightening sanctions. In my comment on that post, I expressed my concern about the hyper-inflation that could follow. Then, you put my mind at ease by stating in your reply that you did not predict what I was afraid of. Now, 300 percent inflation is hyper-inflation by anybody’s definition. What did really go wrong?

Hi there,
How did you come up with 300% inflation rate? The situation is bad alright, but 300% inflation rate. I am not aware of even one commodity price that has increased by about half of what you say, let alone inflation.

Dear Professor Arghami,
We do not have 300 inflation, not yet anyway. We would if it were not for the multiple exchange rate system. And I still do not think energy subsidies are to blame for the current mess. Sanctions would have caused the rial to drop, and we would have lines for gasoline on top of that. We used to import $5 billion of gasoline which is probably more than 15% of this year’s oil revenues..

Djavad jan, Thanks for sharing your thought. Is there any way to have estimate rough inflation rates for some of the imported goods in domestic market? I think that can help to back up the government priorities.

Dear Arash,
You probably mean looking at how fast imported goods prices are rising now, after the fall of the rial. The problem with the test you are suggesting is that with the level of uncertainty in the economy everyone is holding back their inventories. It is probably very hard to buy a laptop or a refrigerator these days, until rial stabilizes. Another problem, which is endemic to the rationing of forex system. Importers who get preferential rates can sell some of it in the parallel market or wait to sell the goods they import. I think when the situation settles, we will see prices rising more moderately, unless the government prints a lot of money to deal with the crisis.